Enel Follows America Movil and Volkswagen with Risky Debt Sales

Italian utility Enel SpA's move to sell almost €2 billion ($2.6 billion) in junior bonds Tuesday — the latest in a string of hybrid bond deals in the last week — came amid signs that the market for riskier corporate debt could be recovering after a halt over the summer.

Enel’s initial attempt in June to sell hybrid bonds–instruments that combine aspects of both debt and equity–was torpedoed as talk about the U.S. Federal Reserve easing the pace of its economic stimulus program roiled global bond markets, causing borrowing costs to soar and deterring new issuance.

Now, with markets more settled after the summer break, borrowers are eager to take advantage of the still relatively low rates on offer. The average yield for non-financial junior corporate bonds issued in euros is 4.37%, according to a Markit index. While yields had moved as low as 3.29% in May prior to taper talk, they were as high as 6.47% at the start of last year.

Enel’s launch highlights a way some companies are trying to optimize their balance sheets by the sale of higher-yielding debt instruments.

On the face of it, Enel will pay more interest on the new paper – €1.5 billion in euros and at least £300 million ($465 billion) in sterling – than it does on its plain-vanilla bonds, as the hybrid versions are junior to such senior debt.

But rating agencies will count the new issue as 50% equity, allowing Enel to stave off the risk of a downgrade that would likely raise funding costs for the Italian power company’s €50 billion or so in gross debt.

That alone has financial value that can help offset the higher costs of the hybrid bond. Another way the hybrid can help Enel is to offer an option on defraying the cost of the company’s €23 billion in liquidity – including long-term credit lines, which also carry a cost for the beneficiary.

Enel has that liquidity buffer to insure against any risk of a credit crunch in the case of renewed market turmoil. That insurance carries a cost. Every 10 basis points of that higher cost amounts to €23 million a year – enough to cover an extra 1.25 percentages points on the hybrid bond yield.

To be sure, the hybrid bond hardly means Enel can shed its liquidity buffer entirely. But it does give added flexibility, and also offers Enel exposure to a new asset class to which investors have taken a shine.

In short, Enel has found a financial Eldorado: a way to deleverage by issuing more debt.

The one big question mark over the operation is why Enel didn’t sell the bonds earlier, instead choosing to scrap them at a time when global yields began to rise on fears that Federal Reserve policy would become less accommodative.

Enel’s bond is the third hybrid sale in the last four trading sessions, following deals from America Movil SAB Monday and Volkswagen AG last Thursday. The latter was the first hybrid bond since GDF Suez’s deal at the start of July.

“A lot of the hybrid issuance we’ve seen this year have been defensive measures by companies seeking to protect their credit ratings, and that’s how I’d interpret the deals this week,” said Jonathan White, an analyst at Aberdeen Asset Management.